Developing a Debt Management Policy

							California Debt and Investments Advisory Commission
The Mechanics of a Bond Sale


        Developing a Debt
        Management Policy

          David Persselin, City of San José
   Jo Mortensen, Public Resources Advisory Group
                    March 13, 2008
                                 “In preparing for battle, I have
Plans vs Policies                found that plans are useless, but
                                 planning is indispensable.”
                                         Dwight D. Eisenhower

  Plans change over time in response to real world
  circumstances
  But policies:
    Are the guiding principles of plans
    Establish core values independent of circumstantial
    stressors
    Frame the decision-making process, even (or especially)
    when the plan deviates from previously stated policies



                                                                     2
Effective Plans are Informed by Policy


                   Debt Management
                        Policy


                        Plan
                          of
      Debt             Finance         Capital
   Affordability                     Improvement
     Analysis                           Plan




                                                   3
Characteristics of Effective Fiscal
             Policies
Explicit
Current
Literal
Available
Comprehensive
Relevant

                                      4
    Fitch Ratings on Management
               Practices
Very Significant              Influential
  Fund balance policy           Contingency plans
  Debt affordability policy     Non-recurring revenue
                                policy
Significant                     Depreciation of fixed assets
  Pay-as-you-go capital         (GASB 34 implementation)
  financing                     5 Year CIP integrating
                                operating cost impacts
  Multi-year forecasting
                                GFOA financial reporting
  Quarterly reporting           award
  Quick debt retirement         GFOA budgeting award



                                                               5
Standard & Poor’s Top Ten Practices
 Established budget      Debt affordability model
 reserve                 Pay-as-you-go financing
 Regular economic and    Multi-year financial plan
 revenue reviews         Effective management
 Prioritized spending    and information systems
 plans and established   Well-defined and
 contingency plans       coordinated economic
 Formal capital          development plan
 improvement plan
 Long-term planning

                                                     6
Debt Management Policies - GFOA
     Recommended Practices
 Purposes for which debt may be issued
 Legal debt limitations
 Types of debt permitted
 Structural features preferred
 Credit objectives
 Methods of sale
 Methods for selecting outside professionals

                                               7
Common Elements in Debt Policy Statements
    1    Purposes and uses of debt                             19   Sale process
    2    Types of debt                                         20   Assessed value
    3    Capital expenditures                                  21   Analysis requirements
    4    Refunding bonds                                       22   Reserve capacity
    5    Disclosure                                            23   Per capita limitations
    6    Statutory limitations                                 24   Size of issuance
    7    Project life                                          25   Intergovernmental coordination
    8    Rating agency relations                               26   When not to issue debt
    9    Operating budget                                      27   Operating revenue
    10   Revenue and TIF bonds                                 28   Lease debt
    11   Bond rating goals                                     29   Capitalized interest guidelines
    12   Misc. limitations                                     30   Market value limitations
    13   Repayment provisions                                  31   Credit enhancement
    14   Maturity guidelines                                   32   Limited tax GO bonds1
    15   General fund revenue                                  33   Inter-fund borrowing
    16   Expenditure limitations                               34   Variable rate debt
    17   Professional services                                 35   Debt service funds
    18   Short-term debt                                       36   Derivatives

           1
               In California, effectively a lease obligation                                          8
Basic Questions to be Addressed in a
            Debt Policy
  What is the purpose of the financing?
  What is the legal authority for issuance of the debt?
  How will the debt be repaid?
  Will bonds be sold with an investment grade rating
  and who will be the ultimate purchasers?
  What are the qualifications of the professional
  advisors and underwriters assisting in the financing,
  and how will they be selected?
  What is the proposed method of selling the debt?

                                                     9
What is the purpose of the financing?
  Is the project to be financed well defined and has it
  received necessary approvals?
     Have construction bids been received?
  Should the project be financed with bonds or on a “pay
  as you go” basis?
     By borrowing, the people who benefit from the project will
     be paying for it (“intergenerational equity”)
     Important to maintain healthy cash reserves
     Never finance operations or maintenance costs


                                                              10
What is the legal authority for the
        issuance of debt?
Financing plan should identify the legal statute
that permits the issuance of the debt
  Issuer’s Bond Counsel will provide it in its Bond
  Opinion




                                                      11
  How will the debt be repaid?
Will the project being financed generate its own
revenues?
   Will bonds be supported by the revenues alone?
   How will on-going maintenance be paid for?
Will a pledge of the general fund be required?
   What is the impact on future budget flexibility?
How will issuing debt affect debt ratios for issuer?
   Debt as % of general fund revenues
   Debt per capita
   Debt to personal income
   Debt as % of Assessed Value


                                                       12
What is the rating requirement for
    the bonds being issued?
 Will bonds only be sold if they achieve minimum
 investment grade rating (BBB-)?
 Will bond insurance be considered?
 Will non-rated bonds be considered?
   Land Secured
 To whom will the bonds be marketed?
   Suitability




                                                   13
How will professionals involved in
   the bond sale be selected?
 Will the issuer create a pool of professionals to use
 on all its financings?
    Bond Counsel, Disclosure Counsel, Financial Advisor,
    Special Tax Consultant, Appraiser
    Benefit from working with core team of consultants but
    periodic review is important
 Underwriter selection process for negotiated
 transactions
    On a RFP basis for each financing?
    Create a pool of Underwriters and select from this pool
    for each financing?
    At a minimum, each firm should demonstrate its
    credentials for each type of financing

                                                              14
What is the proposed method of sale?
  Negotiated Sale
    Issuer and underwriter negotiate the interest rates on the
    bonds and the underwriter’s discount
    Useful for large sales, new or “story” credits, or uncertain
    market conditions
    Typically require independent consultant to verify “on the
    market” pricing
  Competitive Sale
    On an advertised date, issuer receives bids from all the banks
    who wish to buy the bonds
    By definition, is on the market pricing
    Typically used with established credits with high market
    acceptance

                                                                   15
Example of Debt Policy: Land-Based
           Financings
 Clear public purpose          Maximum tax burden
 Active role of issuer         Benefit apportionment
 Applicant credit quality      Special tax district
 Reserve fund                  administration
 Capitalized interest          Foreclosure covenants
 Value-to-lien ratio           Disclosure to bond holders
    Minimum 3:1                Disclosure to prospective
 Annual maximum special tax    purchasers
 burden
    No more than 2% of value
    of home



                                                            16
Example of Debt Policy: Interest
         Rate Swaps
Not to be used for speculative purposes
    Always used in combination with underlying bonds
Define maximum level of swaps in a portfolio
Level of tax risk that is acceptable
    LIBOR swaps versus SIFMA Swaps
Counterparty exposure
    Minimum of AA-
    Diversification of counterparties
Evaluating termination payment exposure
Should be considered in conjunction with a variable
rate debt policy
                                                       17
Example of Debt Policy: Refundings
  Conventional rule of thumb is to achieve present value
  savings of 3% to 5% of refunded bond
     Tax law limits you to one advance refunding, so make
     it count
     Higher savings appropriate if period to call is long
     Lower savings appropriate if time between call date
     and maturity is short
     Higher threshold for refundings with swaps
     Restructuring opportunity in the future?
  Alternative methodology: refunding efficiency (% of call
  option value)
  Flexibility
                                                             18
Debt Affordability Analysis: Effective
      Debt Capacity Policies
  Legal limits
  Public policy limits
  Financial limits




                                     19
   Debt Capacity: A Precious
         Commodity
Debt capacity is limited; make it count
Funds borrowed for project today cannot be
used for other projects tomorrow
Funds committed for debt repayment today are
not available to fund services tomorrow
Long-term capital planning key to managing
debt capacity


                                           20
     Debt Capacity Analysis
How much debt is too much debt?
Why is a policy needed?
What makes a debt policy effective?
How do I construct my own debt policy?




                                         21
       Debt Capacity Ratios
Determining “capacity” is an art, not a
science
Capacity in policies often based on standard
ratios
  Debt as % of assessed valuation
  Debt per capita
  Debt as % of personal income
  Debt service as % of revenues or expenditures
  Determine how to treat self-supporting debt
                                                  22
Developing Debt Capacity Analyses
Identify peer groups
Collect financial data
     CAFRs
     Phone calls
Construct indicators
     For peer group
     For self / compare
Construct scenarios

                                23
 Rating Agencies Have Provided
  Guidance on Debt Capacity
Moody’s
  General Rule: Debt burdens (measured as a % of full valuation) from 0-
  3% is low; 3-4% is average; 5-7% is high, and above 7% is a red flag.
Standard & Poor’s
  February 4, 2000 Research Publication: “Top 10 Ways to Improve or
  Maintain A Municipal Credit Rating”
  June 27, 2006 Research Publication: “Public Finance Criteria: Financial
  Management Assessment”
Fitch Ratings
  June 10, 2004 Research Publication: “Local Government General Obligation
  Rating Guidelines”
  June 27, 2006: “The Bottom Line: Local Government Reserves and Polices that
  Shape Them”




                                                                                24
City of San José – Connecting the
  Dots: Planning to Execution
Budget and financial planning function performed in
City Manager’s Budget Office
  Responsible for budget development and monitoring
  Responsible for revenue forecasting
Debt Management is separate division within the
Finance Department
  Indirect involvement in budget and financial planning
  process through coordinated effort with City Manager’s
  Office




                                                           25
City of San José - 2007-2011 Capital
      Improvement Program
                                2007 -- 2011 Summary
                     Capital Improvement Program Use of Funds

       Neighborhood
          Services
            20%                                               Public Safety
                                                                   5%

 Environmental &
  Utility Services
         14%

                                                             Transportation &
      Community &                                                Aviation
                                       Strategic
       Economic                                                  Services
                                       Support
      Development                                                  58%
                                          3%
          0%


                         5 Year CIP Total - $2,887,972,120

                                                                                26
City of San José - 2007-2011 Capital
      Improvement Program
                          2007 -- 2011 Summary
              Capital Improvement Program Source of Funds

                               Miscellaneous
                                Revenue &
   Taxes, Fees and
                                Developer
      Charges
                               Contributions        Transfers, Loans,
         9%
                                    6%              and Contributions
                                                          11%
   Other
 Government
  Agencies                                                    Beginning Fund
    5%                                                          Balances
  Interest income                                                  30%
    on Invested
       Funds                                                 Sales of Bonds
         1%                                                       38%


                     5 Year CIP Total - $2,887,972,120
                                                                               27
      Funding Approaches
Pay-as-you-go
Grant funding
Capital contributions
Low interest loans
Joint ventures – privatization
Municipal bonds

                                 28
               Summary
Policies Are Powerful
  Fundamental foundation for long-term fiscal
  health: underlying basis for case-by-case decision-
  making
  Provides context for what you would “but for”
  Essential component of any contingency plan
  Articulates your values before they are under
  stress


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Questions?




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